Summary of the (second) consultation proposals

In an initial consultation that closed in August last year, HMT sought views on the case for making “targeted and merited policy changes” to the tax regime for UK asset holding companies held within Fund structures (see a summary of our previous submission to HMRC).

HMT concluded that there was indeed a strong case for reform, and subsequently opened a second, much more detailed, consultation (access the HMT consultation document), which closed on 23 February 2021.

Please see below some highlights of the key proposals outlined in the consultation.

Key principals

1. HMT proposes to introduce a bespoke tax regime for AHCs in Fund structures. A bespoke AHC regime would provide the government with the flexibility to produce reforms addressing the needs of Fund managers, but at the same time limits the potential risks associated with a “more general loosening” of the UK tax regime.


2. HMT recognises that the new regime will ensure that AHCs should pay tax commensurate with its role, whilst ensuring that there is robust eligibility criteria to limit access to intended users. Importantly, the new regime must protect against erosion of the UK tax base, e.g. with respect to UK property investments.


3. The bespoke regime must be consistent with the UK’s commitment to international tax standards, including the OECD BEPS minimum standard and global standards on fair tax competition governed by the OECD’s Forum on Harmful Tax Practices (FHTP).

Specific proposals

1. Capital gains: AHCs should be able to obtain relief for gains on disposals of assets instead of relying on the (more restrictive) existing UK participation exemption (SSE). In order to preserve the UK tax base, the relief would not apply to disposals of UK property or UK property rich assets.


2. Taxable profits: AHCs should only be taxed on an amount of its profit, commensurate to its role as an AHC, using transfer pricing principles. As we set out further below, the consultation sets out alternative proposals with respect to achieving tax deductions at the level of the AHC on its taxable profits, including by way of interest payments on profit participating loans up to the Fund.


3. Withholding tax (WHT) on interest: AHCs should be exempt from UK WHT on payments of interest. Consideration is being given to prevent abuse. To note, the UK does not generally impose WHT tax on dividends (other than e.g. UK REITs).


4. Repatriation of capital to investors: under current UK tax rules it is difficult to repatriate profits from an AHC to investors in the Fund in the form of capital gains. HMT proposes relaxing the current rules, whilst ensuring that amounts returned to UK investors that are attributable to gains in the AHC, should be taxed in the hands of the UK investors as capital gains, irrespective of the form of repatriation, be it dividend, share buyback or liquidation. HMT also proposes stamp duty relief on share buybacks.


5. Hybrid mismatches: the UK’s hybrid mismatch rules would be disapplied with respect to payments made to or from AHCs, to the extent needed to achieve policy objectives.


6. REIT regime: the government is consulting more generally on making changes to the UK REIT regime, e.g. with respect to the listing requirement, and the holder of excessive rights rules.

Eligibility and management

1. The government believes that the rationale for bespoke rules for AHCs is clearest in structures where capital from diverse or institutional investors is pooled and managed by an independent, regulated or authorised asset manager, in which the AHC plays an intermediate, facilitative role. The new rules should not however apply to Funds or companies controlled by a small number of persons, such as members of a family or companies in common ownership.


2. One approach suggested by the government is to look at the Fund itself. The bespoke regime would require the AHC to be wholly owned by a Collective Investment Scheme (CIS) or an Alternative Investment Fund (AIF). To prevent abuse, the investor base would be required to meet the ‘non-closeness’ or the ‘genuine diversity of ownership’ test, to ensure that the fund is set up to benefit a diverse range of investors, with a possible exemption of this test for “qualifying investors” (e.g. tax exempts).


3. The AHC should use an independent asset manager which provides investment management services in return for a fee. HMT proposes that the investment manager should be regulated, and subject to supervision in their jurisdiction. In addition, the manager of the investments should be independent of the investors, although HMT accepts that Managers will have ‘skin in the game’ and / or carried interest, and therefore the regime would need to specify a maximum proportion of the AHC that could be owned by asset managers (ie by way of investments in the Fund).

DLA Piper comment

This is a far-reaching consultation, and if the proposals are adopted, it will hopefully encourage Fund managers to consider the UK as a favourable jurisdiction for establishing Funds. We also welcome HMT’s separate call for input on “Review of the UK funds regime”, which in particular highlights the need for changing the UK VAT treatment of managing Funds, and it is our experience that the widely drawn VAT exemption for investment management in Luxembourg is certainly an attraction.

In addition to points raised in our submissions to HMT (see link) in particular that the AHC regime should have a comprehensive participation exemption on gains (and not a deferral), it is crucial for the new AHC regime to be user-friendly, and relatively straight forward for Fund managers to understand and implement. An AHC regime that provides for a favourable tax outcome, but creates an administrative and reporting headache for Fund managers (and / or requires Fund managers to submit Fund documentation to HMRC), would still fall short of a Funds tax regime that is comparable to other jurisdictions, such as Luxembourg in particular. From attending calls with HMT on this consultation, HMT seem alive to this concern.

Furthermore, two additional challenges stand out for Fund managers looking to set up shop in the UK. The first is the capital gains tax treatment for carried interest. We have had discussions with a number of clients who have expressed unease about the recent Capital Gains Tax Review by the Office of Tax Simplification, in November 2020, that has proposed a rate alignment between capital gains and income taxes. Carry holders are already subject to a 28% tax rate (as compared to 20% tax rate for all other gains, other than residential UK property) and are also subject to an extremely complex carried interest tax regime (with substantial anti-avoidance rules, including DIMF, and IBCI rules, including uncertainty of treatment dependent on whether carry returns are income or capital in nature). Fund managers are typically entrepreneurial and highly internationally mobile, and raising the rate of capital gains tax would likely be counterproductive to encouraging Fund managers to base their management teams and Fund vehicles in the UK. Following the Spring Budget , we were pleased to note that there will be no change in capital gains tax rates until at least April 2022, but it would be very helpful to the success of the new regime to know that the current rates will not be increased beyond that time.

Secondly, Brexit has given rise to challenges with respect to regulation of Funds. UK AIFs and AIFMs have, as a result of Brexit, lost access to the current marketing and management passport under the Alternative Investment Managers Directive 2011/61/EU (AIFMD). Although it is hoped that a further agreement will be reached with the EU granting equivalence to UK AIFMs, under current rules, to gain access to EEA markets post-Brexit, UK AIFMs now need to go via the National Private Placement Regime or rely on ‘reverse solicitation’ which requires the EEA investor to approach the UK AIFM without any prior communications from the UK AIFM. These requirements pose a significant challenge to UK AIFMs seeking to market to EEA investors.

At the same time, HMT’s proposals to creating a bespoke, tax regime for Funds, if implemented, would be a giant leap forward to encouraging Fund managers to set up their Fund vehicles in the UK.